Incentive

by Mr. Cheap

I feel like an often-overlooked perspective in life is why people do the things they do, that is, their incentive.

Quite a while before “Freakanomics” came out (great book, read it if you haven’t yet) I had the epiphany that Real Estate agents weren’t being paid properly to achieve what is generally thought of as their principle aim: to sell your property at the highest price. They are paid a percentage of the sale (usually 5% in Canada) and they get 5% of the ENTIRE sale price.

Say I had a house worth $100,000. Any chimp could sell it for $50,000. But I’m paying them 5% of the nothing-to-it, super-easy-to-sell first $50,000 of the sale price. It probably wouldn’t be too hard to sell it for $75,000 (in both cases the challenge would be reassuring people that there wasn’t some hidden defect). Again, I’m still paying them 5% of the entire sale price, even the majority of it that would be very easy to sell.

The incentive that *WOULD* encourage agents to get top dollar would be if you split with them however much they got above a certain price, or if they got to keep the ENTIRE amount above a certain price (e.g. if I said I’ll give you 50% of anything paid over $95,000, or if I said I’ll take the first $100,000 of the sale price, you get anything left over).

Since they’d have to work harder in these situations, obviously agents wouldn’t be interested (actually some agents would be very interested, and would probably do very well in such a situation, the challenge would then become haggling with the seller over the “low-end” price, and haggling with the buyer over the “high-end” price, the further apart these went, the more money for the agent).

Its true in many (all?) fields that how the person is paid determines how they do their job. Financial advisers who get paid on commission have an incentive to sell you the products that pay them the highest commission (note, they don’t make money for increasing your wealth, they get paid for SELLING you things), 9-5’ers have an incentive to maintain their jobs (and maybe get extra hours), not to be productive (greater productivity isn’t directly rewarded, it *MAY* get you a raise, but it just as easily might not, why kill yourself for an extra 2%?), teachers get higher academic qualifications to increase their pay not to be better educators (so you get gym teachers who have a Masters from a school no one has ever heard of), etc, etc, etc.

Joel on Software debunks the “Econ 101 Management Style” which tries to tie pay to performance, and I agree with him generally, but at the same time I think many professions are already “gaming the system” and that things could be improved.